Measuring and Building Your Own Portfolio

When you buy any share of stocks, it becomes part of your portfolio. Your portfolio includes all your investments, whether it was cash, real estate, stock, or stock mutual funds. Your objective is to build a portfolio that will help you meet your current financial needs and achieve your long-term financial goals.

Strategies

When you start building your portfolio, you need a plan or a strategy to guide the decisions you make. Otherwise you could end up buying and selling investments randomly and falling short of your financial goals.

1) Buy and hold: If you are investing with long term goals in mind, this needs you to build a portfolio of a few solid stocks or mutual funds and keep them through ups and downs in the market. The expectation is that they will gain value in the long run, despite some short-term losses during downturns in the stock market.

If you are constantly buying and selling, you might miss out on this long-term growth and pay a substantial amount in fees to authorized persons. Of course this does not mean you should hold onto a stock or mutual fund if it consistently provides a smaller return than comparable investments. You should not be afraid to purchase new investments with your earnings.

2) Asset allocation: Asset allocation means dividing your portfolio among different types of investments, called asset classes, such as stocks, cash, and real estate. Some asset classes, such as stock, have more potential for growth but are also more volatile, while others, such as cash, are more stable in price but often grow more slowly.

In addition, different classes perform best at different times, based on what is happening in the overall economy.

By planning how much of your wealth you are going to invest in each asset class you can create the mix of growth and stability that is right for you. You can, also take advantages of different market cycles. The allocation you choose may be aggressive, moderate, or conservative. An aggressive portfolio is more heavy in stock, while a conservative portfolio includes more cash and bonds.

Diversification

Owning a variety of investments within each asset class is also essential to achieving a strong, balanced portfolio.

For example, suppose you invest all your money in one or two stocks, or stocks that are very similar to each other because the companies that issue the stock are all in the same business. In that case, the growth and security of your entire portfolio will depend on the performance of a few companies or ones that are very similar.

If these investments suffer losses, you could lose a substantial amount of money. If you invest in several different types of stock, on the other hand, you will be in a better position to protect your portfolio and benefit from many different strong areas of the economy.

For example, you may invest in large and small companies, companies in different sectors of the economy, some stocks with growth potential and others that pay dividend income.

Matching Investments to Goals and Risk Tolerance

The investment distribution you choose for your portfolio should be in line with your financial goals and reflects your investment style. If you have a high risk tolerance, you may want to choose a more aggressive allocation. As you approach an important goal, like retirement, it might be better to keep your money in safer investments.

Measuring Portfolio Performance

Even after you have created a portfolio that works for you, it is important to be careful about your investments. You want to make sure that they are performing as well as you can reasonably expect them to, and that you make changes to your portfolio to meet your evolving goals.

For example, you might decide to sell a stock that has turned out to be much riskier than what you have expected, especially if it means that your entire portfolio becomes more risky.

It is a good idea to go through your portfolio about once a year to evaluate each of your investments and to make any necessary adjustments to your asset allocation.

Total Revenue

When you are trying to evaluate a stock or a mutual fund’s performance, the first step is to figure out its total revenue. This number takes into account any gain or loss in value, plus any dividends you received.

If you own a variety of investments, you may find it difficult to evaluate their performance in relation to each other. To compare return across investments you can calculate the percentage revenue for each one of them.

You can calculate the percentage revenue by dividing the total revenue by the initial cost of the investment. For example, if you invested $3,700 in a stock with a total return of $750, your percentage return would be 20%. And if you invested $70,000 in a stock with a total return of $8,500, your percentage return would be only 12%. So in this case, the smaller investment would have a better percentage revenue.

Using Benchmarks

In addition to calculating returns to evaluate your investments, you can also look at your investment’s performance in comparison to the overall market by using a benchmark, or a measuring criterion.

A benchmark is usually an index that tracks the performance of a selection of stocks within a market or a sector in order to measure the performance of the market or the sector as a whole. Comparing your results to an index can give you an idea of your portfolio’s performance.

For example, if stocks in your portfolio lost 5% last year while the stocks included in the index gained 15%, you might need to reevaluate your individual investments to understand your disappointing results. But make sure that the index you use tracks investments that are similar to the ones you own, so you are comparing similar types of investments.

When to Rebalance your Portfolio

As investments in your portfolio either gain or lose value, your asset allocation might change. That is because if one asset outgrows the others, it will eventually take up more of your portfolio than it did before. For example, if your portfolio had 60% invested in stocks, with 40% in other assets, and stocks performed very strongly over a period of time, you might end up with 64% in stocks and only 36% in other assets. This could leave you exposed to more risk than what you intended.

One way to rebalance your portfolio, or restore the allocation you want, is to sell off some of the assets that have grown the most, and use the proceeds to purchase more of the investments that have fallen behind.

While you may be hesitant to sell some of your most valuable assets, you will be actually selling high and buying low, which is a good strategy. You can also use the money you set aside for investing each month to purchase more of the lagging asset, until your allocation is back to the balance you want it to have.

Some investors rebalance once a year, but you may follow a different schedule depending on your financial goals and changes in your life or finances.

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